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JCPenney on the Recovery Trail! Not So Fast, Says Amazon

If you've read any of the articles that I've written about struggling (yes, they're still struggling) retailer J.C. Penney (NYSE: JCP) over the past 18 months, you know where I stand. I'm not impressed with what former-come-again CEO Mike Ullman and his team have done and are doing. The things that they've chosen to do -- I'm lookin' at you, 39% shareholder dilution -- have destroyed shareholder value that will probably never be recovered for longtime investors.

With the Q1 earnings now out, there's a lot of positive momentum behind the stock, and frankly, it's in the face of some relatively damning evidence that Penney isn't anywhere close to a full recovery yet. Amazon.com (NASDAQ: AMZN) and a bevy of other Web retailers are showing how much the dynamic has shifted in the way consumers want to shop. So before you decide to invest in J.C. Penney, I think it's a good idea to look past the last six months and even past the disastrous year before.

Frankly, Amazon is the better investment today and far into the future. Let's talk about why.

When good numbers are just less awful J.C. Penney reported same-store -- or comparable -- sales growth of 6.2% in the quarter after reporting 2% comparable-sales growth in Q4, including a 3.1% sales increase during the all-important holiday shopping season. So, while I have to give credit where credit is due -- sales growth two quarters in a row is a positive achievement for the company -- it's way too early to call this a turnaround. After all, Penney is still selling less merchandise than it was in 2012, and by a pretty wide margin.

In Q1 of 2012, J.C. Penney's total sales were $3.152 billion, versus $2.8 billion in the just-announced first quarter. That's still a double-digit decline in sales, and far from a clear indication that the company is back on the right long-term track to stay. Let's take a look at the long-term trends for quarterly sales for Penney and Amazon:

Going back for a decade, it's pretty clear where consumer demand is headed.

Unfair comparison? Maybe, but probably not. I think the reality that Penney investors -- and management -- must face is that consumers are rapidly shifting to online purchasing for essentially everything, from consumer goods to housewares and even clothing. The biggest challenge that Penney faces right now is that it's still not really clear what it's going to be when it grows up.

While Amazon has become identified as the "everything" store, and often the first and last place many shoppers go to for almost everything, J.C. Penney is stuck between its legacy of coupons and "always on sale" -- a legacy that was in decline and led to Ullman's ouster in 2011 -- and the failed attempt by Ron Johnson to implement a new strategy to attract new, and more affluent, customers to the stores. The Penney of today is still in limbo, with no real clear path forward, outside of the return to heavy discounting and coupons under Ullman since his return.

Still losing moneyAmazon detractors often point at the company's very thin margins, and narrow profits, as an indication that the company's model is not sustainable. But the difference between Amazon's and J.C. Penney's financials is very clear: One is investing heavily in expansion and one is bleeding cash and still in decline:

Penney's operating income was still a $247 million loss, even though it was improved from a year ago. That's a billion-dollar operating shortfall for a full year if it's not quickly improved. That's just not a recovery.

Don't jump the gun As harsh as my criticism of Ullman and his team has been, I laud them for still doing what they can to save the business despite the beating they've taken. However, it's still pretty clear that shareholders have been hammered, and many will never recover what was lost, and I'm just not convinced that Ullman and team have made the best decisions with regard to shareholders, the owners of the business.

With that said, Penney could turn into a good investment, but I think we need to see the company hit its guidance for the rest of the year first: reach breakeven free cash flow, continue to recover comparable-store sales, and improve liquidity significantly.

Frankly, until J.C. Penney demonstrates that it can return to sustained profitability, it remains a speculative, risky investment. Amazon, on the other hand, will continue to grow for many years to come. With the stock down almost 25% this year, Amazon has far more predictable upside.

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Comments from our Foolish Readers

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Sometimes the headlines get changed in the editorial process, and I'm not in love with how this one was changed, but I stand completely behind the content of the article.

The reality is JCP still has a long way to go, and consumers are shifting away from traditional retailers like it, and towards retailers like JCP. These combine to make Amazon a fantastic company to own, and JCP a risk-laden investment based on a recovery that's no guarantee.

Yes - JCP has a long way to go to return to profitability - without a doubt.

What that has to do with Amazon? Not much in my opinion.

If you want to make the "consumers are now buying on the web" argument - that's fine. JCP,com web sales have been quite strong and they brought on board an OmniChannel expert to strengthen that part of the business.

My point? Comparing JCP to Amazon as competitors, or whatever correlation the author was trying to make, does not carry much weight to me. Both JCP and AMZN can be compared to other companies that are not as much of a "stretch" as comparing them to each other.

I'm the author. The comparison (not really a correlation) is of a company with tremendous growth potential and one that will face serious challenges to grow, even if/when it does return to profitability.

It's also a solid contrast between legacy, traditional retail and online shopping; the trends are pretty clear as to what is happening.

Consider this: JCP still was well short of sales from 2012 -- 2 years ago -- while growing its online sales some 20%+.

Is that really the kind of business you want to invest in today? There isn't a bunch of hidden asset value, so this isn't a value play a la Ben Graham. It's too early to call it a turnaround, a la Lynch. That leaves a declining, unprofitable business. High-risk speculation, and nothing more.

Before one writes kind of article or invests in a company, its a good idea to go to JCP stores and see how the traffic is. You'd be amazed at how many people are starting to return back and for the first time in the last 3 years that I've been shopping there, I encountered a line during checkout. Sales are going up as demonstrated in the last 2 quarters, and this will improve free cash flow. If you don't get into this stock, soon it will be too late. This stock is going to be over $13 by same time 2015, which represents a 20+% return.

My past experience qualifies me to comment on jcp. There is no doubt that this company is in the throes of a turn around. Please if you are one of the skeptics do yourself a favor and visit one of the stores.

As to on-line sales; clothing is one of the few things that people want to try on and not have the hassle of returning merchandise. I was a financial analyst for over 30 years. Buy the stock, it is a great investment.

I say it again, the headlines sometimes get changed in editorial. I agree that this one isn't ideal. I wrote as much earlier.

Taking the headline out of the conversation, I stand behind the article 100%, because it highlights the larger trend with both JCP and Amazon: consumers want something different than what JCP offers. Amazons value, convenience, and continued growth is a much better long-term bet than a JCP turnaround.

I can't say it any plainer than that. That's my agenda. Cautioning people from mistaking JCP for some turnaround or value play, while Amazon is staring us in the eye as b

I'll take credit for the change in headline; my apologies to Jason. My contention is that investors need to be cautious and not simply take short-term trends as a clear indication of a turnaround. Perhaps it will be, but it might not be that cut and dry.

I'd caution anyone to blindly consider the company's historical operating leverage to remain intact. In other words I'm not so sure we should simply assume that so long as the top line is restored and customers come back, that margins will follow.

Amazon comes into play, in my mind, as a threat to JCP's business. Yes, I understand the argument that shoppers want to try clothing on (apparel is only one component of JCPs revenue mix BTW) before buying. Hence Amazon couldn't hurt this part of the business. The funny is, though, that's exactly the same thing everyone said years ago about Amazon when it came to selling other goods.

Is it that hard to believe Amazon could potentially disrupt apparel retail? Could JCP or other retailers become a showroom for Amazon? Even if not, could amazon still pressure the industry to maintain thin margins in order to win customers? Shoppers may return, but how much cash flow will JCP actually derive from them?

I'm certainly open to dissenting opinions - that's what's so great about the Fool! But, please, direct your criticisms away from Jason and to me.

But if the answer to who are you? is that you are the "editor" that created the "not so fast SAYS AMAZON" headline....then you have zero credibility in my book and you left the author Jason out to dry.

I think your attack on Mike is out of line. It's pretty easy to -- in the anonymity of the web -- toss virtual monkey poo at total strangers, but you shouldn't do it just because you can.

Your focus on the headline -- versus the content of the article -- is just beyond me. Why do you find it so offensive?

It's not like it's really misleading in any way, despite not being what I would have chosen myself. What it speaks to, i.e. the significant consumer trend away from legacy retailers like JCP and towards Amazon and others, is relatively spot-on.

--Amazon has grown sales at very close to 20% per year for more than a decade.

--JCP did $20 billion in 2007; <$12 billion last year, and is still off its 2012 levels in 2014.

There's a pretty clear long-term trend happening. Oh, and 39% more shares outstanding than there were at the peak.

Instead of name-calling and attacks on people's credibility, -- people who you don't know beyond a few hundred words or less -- how about a reasoned, compelling argument against what I've written?

How about it? We've been nothing but respectful to you. Maybe you should try it for a change.

Sending report...

Born and raised in the Deep South of Georgia, Jason now calls Southern California home. A Fool since 2006, he began contributing to Fool.com in 2012. Trying to invest better? Like learning about companies with great (or really bad) stories? Jason can usually be found there, cutting through the noise and trying to get to the heart of the story.
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